Which of the following are underlying assumptions of cost volume profit analysis?

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  Inhaltsverzeichnis Show

  • Cost-volume-profit or break-even analysis objectives
  • Assumptions
  • Our purpose is to transform access to education.
  • Introduction
  • Costs are classified into variable or fixed
  • Linear relationship within a relevant range
  • Inventory level does not change from period to period
  • Volume is the only factor affecting variable costs
  • Selling price is constant
  • What are the assumptions underlying cost
  • Which of the following are underlying assumptions of cost
  • Which of the following is not an underlying assumption of cost
  • Which of the following assumptions is false with respect to cost

This is a short article that will walk you through the objectives of CVP analysis and some common assumptions revolving around the process.

Let’s try to understand the core objectives of cost-volume-profit (CVP) or break-even (BE) analysis followed by some assumptions underlying these objectives.

Cost-volume-profit or break-even analysis objectives

• To forecast profits: helps to identify profit relationships, costs and volumes for determining relative profitability and to compare inter-company profitability
• To set budgets: is useful in setting up flexible budgets that indicate costs at different activity levels
• To evaluate performance: helps performance evaluation by focusing on profits achieved and costs incurred
• To set pricing: plays an important part in stabilising volume. BE analysis helps organisations to formulate pricing policies
• To determine overheads: helps to determine the number of overheads that should be allocated to product costs at different levels of operation
• To achieve capacity: focuses on the importance of achieving capacity to achieve economy.

Assumptions

Here are some assumptions about the use of CVP analysis in business.

• CVP analysis costs can be segregated into fixed and variable portions and total fixed costs remain constant at all output levels.
• In CVP, cost linearity is preserved over the relevant range, and revenues are constant per unit.
• A business has a constant product mix and produces only one kind of product.

An efficient manager or business owner tries to bring out the best results from cost-volume-profit analysis, while steering clear of assumptions.

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Introduction

Cost-volume-profit analysis (CVP analysis) helps a business in planning and decision-making. It provides information on how profits and costs are affected by changes in volume or level of activity.

The CVP analysis is subject to the following limiting assumptions.

Costs are classified into variable or fixed

All costs are presumed to be classified as either variable or fixed. In the real business environment however, costs behave differently. Users of CVP analysis need to be able to identify variable costs from fixed costs, and vice versa. Also, different methods are used to segregate mixed costs into purely variable and purely fixed.

Variable costs per unit are constant. Total variable cost changes directly with the volume of activity. On the other hand, total fixed costs remain constant regardless of the level of activity.

Linear relationship within a relevant range

Cost and revenue relationships are linear within a relevant range of activity and over a specified period of time.

Say for example, the fixed costs from 1 to 100,000 units might be different from the fixed costs at 100,001 and above. Variable cost per unit may also be different. Hence, we assume that we are working within one relevant range for which the behavior of fixed and variable costs are applicable.

Inventory level does not change from period to period

It is assumed that all units produced are sold during the period; hence, there is no change in beginning and ending inventory levels.

Volume is the only factor affecting variable costs

As volume (or level of activity) increases, the total variable cost increases directly with the change in volume. If the variable cost per unit is, say $5 per unit, the total variable costs would be equal to $5 multiplied by the number of units produced. It is important to take note that volume is the only factor affecting total variable costs. The variable cost per unit is assumed to be constant. Productivity and efficiency are ignored (assumed constant).

Selling price is constant

The selling price and market conditions are constant. Also, if the business produces and sells multiple products, the sales mix is assumed constant.

Conclusion

Despite its limitations, the CVP analysis is a useful tool in decision-making when used correctly. The limitations simplify the process of analyzing the effect of changes in activity level to costs and ultimately to profit. CVP analysis provide information to aid managers in determining the break-even point and in setting short-term goals such as sales targets, profit objectives, production budgets, and pricing strategies.

Key Takeaways

CVP analysis assumes the following:

1. Costs are segregated into purely fixed and purely variable
2. Costs behave in a linear manner, within a relevant range over a period of time
3. Units produced is always equal to units sold (P=S), hence no change in inventory
4. Volume is the only factor affecting variable costs, hence variable cost per unit is always constant
5. Selling price is constant

Web link

APA format

Assumptions in CVP analysis (2022). Accountingverse.
https://www.accountingverse.com/managerial-accounting/cvp-analysis/cvp-assumptions.html

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Chapter Outline

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What are the assumptions underlying cost

Which of the following are underlying assumptions of cost

Which of the following is not an underlying assumption of cost

Which of the following assumptions is false with respect to cost